When President Donald Trump tapped Kevin Warsh in January to become the next chair of the Federal Reserve, the policy debate centered on when, not whether, interest rates would fall.
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Four months later, the economic challenges Warsh inherits after being sworn in Friday have all but eviscerated expectations of any immediate decrease in borrowing costs.
Inflation is rising again, and the war with Iran has raised concerns that surging commodity prices could broaden out and morph into a more persistent problem. Officials at the central bank have begun to embrace the possibility that rates may need to rise to get inflation back to their 2% target, a reality that has rattled global bond markets and sent yields on U.S. government debt soaring.
Higher rates are far from what Trump wanted from Warsh. The president had long stipulated that whomever he chose to replace Jerome Powell — who faced such aggressive attacks from Trump that he decided to stay on as a Fed governor after his term as chair ended to safeguard the institution — agreed with him about the need for lower borrowing costs.
But even Trump now appears cognizant of the tough task ahead for Warsh. Days before his swearing-in, which was held at the White House for the first time in roughly 40 years, the president said he would let him “do what he wants to do” on rates.
“The president wanted the Fed chair to come in and cut rates, and that was a very plausible story several months ago,” said Joseph Lavorgna, who until recently served as an adviser at the Treasury Department. “But the way the economy and the geopolitics have evolved, it just doesn’t make it likely, at least in the near term.”
Lavorgna, now chief economist at SMBC Nikko Securities America, said the Fed’s next move was more likely to be a rate increase. “How much is hard to say,” he added.
Long before the war with Iran began, Warsh promoted several theories for how the Fed could approach its job differently and open new pathways to lower rates.
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He has argued that the Fed has fundamentally misunderstood how inflation gets embedded in the economy and focused too much on growth, rather than overzealous fiscal and monetary stimulus, as a source of price pressures. Its approach for measuring inflation was also flawed, he contends, emphasizing instead a shift toward real-time metrics and those that remove outliers caused by tariffs and energy shocks, for example.
To Warsh, the Fed has also underappreciated the magnitude of the economic shift due to artificial intelligence and other policies that boost supply, like deregulation. He expects wider use of the technology to unleash a productivity boom that will eventually help temper inflation, giving the Fed space to lower rates.
He has also argued that if the Fed shrinks its massive portfolio of government bonds and mortgage-backed securities, it can offset whatever increase in long-term rates is likely to follow by lowering short-term ones.
The appetite among Warsh’s 18 new colleagues at the Fed — 11 of whom will vote alongside him on policy matters — to take a leap on any of these theories appears tepid at best. Resurgent inflation has honed policymakers’ attention on the latest data, as they search for signs that their policy settings are tuned appropriately.
According to Michael Feroli, chief U.S. economist at J.P. Morgan, there is little evidence that rates at the current range of 3.5% to 3.75% are constraining the economy.
The labor market has held up relatively well, with the unemployment rate stable at 4.3%. Consumers, buoyed by ebullient stock markets, are still spending. And economic growth has defied the odds and expanded at a solid pace.
“It just doesn’t feel like we’re restrictive,” said Feroli, who forecasts the Fed to hold rates steady for the rest of the year before raising them in 2027. “We might even be easy.”
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